It is likely that President Obama's National Commission on Fiscal Responsibility and Reform will include a value-added tax (VAT) as part of a deficit-reduction package to be delivered after the November elections. The problem is that there is a fundamental flaw in the VAT that more than offsets its revenue-raising appeal: Increasing taxes on a particular activity produces less of that activity, and as a general rule, economies are less prosperous when value-added efforts decrease (or are hidden or disguised in order to evade taxes). Democrats certainly understand the nature of the relationship between taxes and behavior, as they push various sin taxes - on cigarettes, alcohol, sugary beverages, junk food, wealth accumulation, etc. It is far more logical, then, to assess an inverse value-added tax, or iVAT, on activities that subtract value. In that regard, the obvious place to start is federal, state and local governments.
Despite its inherent illogic, a VAT is a seductively appealing trifecta for progressive deficit hawks: It is relatively hidden in product prices; it can raise an enormous amount of revenue quickly; and it puts a great deal of additional power into the hands of VAT-crats, federal officials who decide VAT winners and losers. A VAT puts the fear of government into those business owners who aren't already true believers in the hegemony of the public sector. Unfortunately, the unblemished record of VATs is that they don't close budget deficits when they're grafted onto an existing income-tax system. As economies strengthen, extra VAT revenues disappear in more entitlement spending and more vote-buying. So, experience suggests that VAT rates increase over time, as do deficits. Higher taxes and deficits crowd out and depress private-sector activity. In general, it appears that economic growth slips about 1 percent per year on average (at least that's been true in Europe relative to the U.S.), unemployment stays high and the net result is a significant drag on living standards over time. No matter how a VAT is sold to the public, actual experience shows time and again that it has been an enabler of public-sector expansion, not a prudent path to deficit reduction.
The beauty of an iVAT aimed directly at the government is that it would be exactly the same as a government spending cut, but, at the same time, completely different. That may sound a bit illogical on the surface, but it's modus operandi in government, where a "cap-and-trade" bill can be resubmitted as the Clean Energy Jobs and American Power Act and no one is supposed to notice. If we've learned anything in the past 18 months, it's the power of labels. Cuts in government spending arouse passionate push-back by special interests that are on the receiving end of government "investments" (i.e., income transfers). An iVAT is, by contrast, a revenue-raising, fiscally responsible tax.
The federal budget for fiscal 2011 includes $3.8 trillion in spending (versus $2.6 trillion of revenue). Why not ask every single department of the federal government to issue a one-page summary of how it adds value and show the metric used to calculate its value added? Then, an iVAT Commission on Federal Government Fiscal Responsibility (composed exclusively of American taxpayers) would evaluate the processes and render a verdict as to what activities truly add value. Those departments that can't demonstrate clear value added would be assessed an iVAT of 20 percent, to start. So, for example, if the Agriculture Department ($146 billion budget) is deemed to be a net economic negative, an iVAT of approximately $30 billion would be subtracted from its budget; that sum would be rebated to taxpayers or put in a deficit-reduction lockbox. Other possible iVAT targets would be Housing and Urban Development ($53 billion), Health and Human Services ($934 billion), Labor ($117 billion), Education ($94 billion), Treasury ($593 billion), the Environmental Protection Agency ($11 billion) and the Office of Personnel Management ($73 billion). Add those numbers to the Agriculture budget, and there's a potential $400 billion of iVAT revenue. Again, this wouldn't be a heartless cut in valuable government programs, it would be a tax that would redeploy revenue to value-added generators that are better for the common good (more growth, more jobs, more income, etc.).
Progressives seem pretty smug in their belief that Washington's European-style spending (now 25 percent of gross domestic product and rising) has boxed limited-government deficit hawks into a corner. For the good of our children and our grandchildren, we all must sacrifice now, and a VAT will be advertised as fair and relatively painless way to restore fiscal sanity. But do Democrats really want less value added in the economy? For our future generations, shouldn't we tax things that add no value or actually may subtract value? An iVAT makes much more sense, directed first at federal and state government activities and perhaps political campaign spending ($5.3 billion in the 2008 election cycle). With regard to the latter, imagine a political campaign iVAT of $1 billion rebated to taxpayers; that would almost make it pleasurable to watch ads showing one candidate hates children and the other wants to kill grandma. Surely Washington's fairness advocates would support an iVAT on bloated bureaucracies that add no value; it's basically the same as beverage and junk-food taxes to discourage obesity, another sin tax, if you will.
Philip Grant is an adviser to institutional money management firms and a consultant to corporate pension fund sponsors.
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